AD AGENCY COMPENSATION – OVERPAYING OR UNDERPAYING?

When it comes to most advertising agency/client relationships there is one certainty – someone is taking advantage of someone.

This is not usually the result of someone purposely trying to take advantage of a business partner. More often, it’s the result of neither party understanding how to put together a basis of compensation that is realistic, fair, and – most importantly – accurate.

For decades, the advertising agency business operated on a 15% commission basis, meaning that agency compensation was generated by a media commission on placed media, production, and/or other forms of out-of-pocket payments on behalf of the client.

In the Mad Men days of Madison Avenue’s early giants and their clients, the large budgets of most national clients led to agency paydays that could only be described as largesse. Agency owners enjoyed astounding paydays. More than one agency owner purchased castles in Europe and at least one even bought an island. An island.

Not everyone enjoyed that bounty. For every agency rolling in mountains of cash, there were many more – the majority, actually – that struggled to meet every need and answer every client request. The 15% flat commission created an all-you-can-eat arrangement that generated problems for both agencies and clients.

For many agencies, the problems were obvious. They weren’t making enough money to pay for the work being performed. Their margins dropped or, in extreme cases, disappeared. Rather than renegotiate their deal or resign an unprofitable account, many responded by cutting back on staff assigned to the accounts or staffing the accounts with fewer – and less experienced/qualified – staffers. This led to work that wasn’t as experienced, wasn’t as strategic, and wasn’t as effective.

For clients, the problems were equally obvious. Work done by less experienced, cheaper staffers sometimes failed to achieve desired results, and often led to an inevitable decline in the relationship that, unless corrected, spiraled into the end of the relationship.

So, the paradox in this type of arrangement is that while one side initially suffers financially, both sides ultimately pay the price of this compensation problem.

The odds of a 15% commission basis being exactly right are slim, of course. If the work performed does not equal the dollars generated by that 15%, then the arrangement is unfair to the client. If the cost of the work performed exceeds the income generated by that 15% arrangement, then the agency is losing money.

There is an easy answer to this, though. It can be described in the formula:

COS (Tasks x Staff x Hours + Overhead) + Margin = Compensation

This formula is easy to tackle and it will deliver fair compensation, guaranteed. Following these simple steps to deliver an approach that will work for the agency and the client:

TASKS

The first step towards establishing realistic compensation is to define – accurately and exactly – what the agency will be expected to do on behalf of the client. This can usually be done in one or two sit-down meetings with a new client where the agency and the client agree on what specific tasks or projects will be covered under agency compensation.

This is easier than it sounds. In any new relationship, the agency likely won the account based on at least some level of understanding of what the client hopes to accomplish with their new agency. Most agencies will be able to translate that into a set of likely tasks along predictable lines – strategy, planning, advertising, digital environment, sales promotions, public relations, media, etc., – that can be used to spawn likely tasks.

In ongoing relationships, the previous year’s work will help shape the list of anticipated tasks.

Whether new or ongoing, it is important that the agency and client agree that the resulting list is a fair and accurate estimate – based on current knowledge – of what the agency will be expected to deliver, and for what compensation.

It is important to plan for the unexpected. There will usually be additional tasks generated at the rate of 10%-15% of the estimated workload. To account for this, the agreement should allow for new project compensation in one of two ways:

Include a pool of project money in the overall agreement. A pool of 10%-15% of the overall budget should cover most projects that could crop up. The pool can be tracked on a monthly basis.

Simply estimate any out-of-scope project on an hourly basis for prior written approval by the client.

STAFF

Once tasks have been identified and agree upon, the next question is WHO will do the work? For each project or area of responsibility, determining who will do the work will define whether senior people are needed, more junior staffers, or someone in between.

HOURS

Once the list of specific people or disciplines required for the agreed-upon work has been created, the next task will be to determine how much time it will take to perform the expected work. This part of the formula (Tasks x Staff x Hours) is the heart of any accurate compensation structure.

OVERHEAD

After you’ve determined TASKS + STAFF x HOURS, you will need to determine the overhead factor for the work. This overhead factor is different for each agency and depends on a variety of things tied to running a business. Like all businesses – including all clients – agencies have an overhead factor that must be considered in determining compensation levels. This agency overhead must be factored into the discussion.

Cost of service is just what it says – the actual cost the agency incurs for delivering the anticipated work. It is extremely important that the client (and agency personnel) understand that this is NOT AGENCY PROFIT. This is COST to the agency of performing the needed work for the client.

MARGIN

Agencies have different ideas about what an appropriate margin should be. Whatever the desired margin is (within reason, of course), it should be added to the COS to determine the overall compensation.

COMPENSATION

Once you’ve gone through all these factors, you should end up with a compensation worksheet that looks something like this:

2,000 hours

X staff cost = $150,000

Overhead = $150,000

COS = $300,000

Margin = 20% ($60,000)

Total compensation = $360,000

COMMUNICATION

Finally, the key to making this work long term is ongoing proactive communication. It’s a healthy practice to discuss compensation not just annually but also frequently so that both partners can be assured that the agreement is working as anticipated and desired. Regular check-ins that track progress against the budget can help avoid unpleasant surprises for either side.

There you have it: a simple plan to make sure that your agency compensation agreement is fair, equitable, and accurate. It will keep everyone happy and will ensure that the right tasks are being performed, by the right level of staff, at the right rate, to achieve optimal compensation that is fair for both partners.

DAVID HADELER is brand strategist at The LOOMIS Agency, the country’s leading challenger brand advertising agency and a top ad agency in Dallas. For more about challenger branding, subscribe to our blog BARK! The Voice of the Underdog

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